Today we'll evaluate Kingold Jewelry, Inc. (NASDAQ:KGJI) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Kingold Jewelry:
0.21 = US$243m ÷ (US$2.9b - US$1.7b) (Based on the trailing twelve months to March 2019.)
So, Kingold Jewelry has an ROCE of 21%.
Is Kingold Jewelry's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Kingold Jewelry's ROCE is meaningfully better than the 12% average in the Luxury industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Kingold Jewelry's ROCE is currently very good.
Our data shows that Kingold Jewelry currently has an ROCE of 21%, compared to its ROCE of 7.1% 3 years ago. This makes us wonder if the company is improving. The image below shows how Kingold Jewelry's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. You can check if Kingold Jewelry has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Kingold Jewelry's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Kingold Jewelry has total liabilities of US$1.7b and total assets of US$2.9b. Therefore its current liabilities are equivalent to approximately 60% of its total assets. Kingold Jewelry boasts an attractive ROCE, even after considering the boost from high current liabilities.
The Bottom Line On Kingold Jewelry's ROCE
So to us, the company is potentially worth investigating further. There might be better investments than Kingold Jewelry out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.